Annuities Deferred Income Annuities Fixed Index Annuities Longevity Insurance

Longevity Insurance is an App

App: A self-contained program or piece of software designed to fulfill a particular purpose (Google Definition). A smartphone would be nothing more than a paperweight if it didn’t have any apps. The most basic function of a smartphone, i.e., making and receiving phone calls, wouldn’t be possible without a phone app.

Apps are the lifeblood of a smartphone. Mobile phone and data plans generate billions of dollars of revenue each year for wireless communications companies. The phone, itself, is secondary, and, as such, is typically heavily discounted when phone and data plans are purchased.

An analogy can be made to longevity insurance. Many, if not most, people are under the mistaken belief that when they purchase longevity insurance, they’re buying a product (i.e., smartphone) whose sole purpose is to provide them with lifetime income beginning at age 85 in the event that they live to a ripe old age.

Let’s dispel two myths. First of all, there’s technically no such thing as a longevity insurance product. You won’t receive a “longevity insurance” contract from an insurance company. When you buy longevity insurance, you’re buying an app. In order to use the app, you will need to purchase either a deferred income annuity (“DIA”) or a fixed index annuity (“FIA”) with an income rider, with DIA’s being favored as the traditional longevity insurance product.

DIA’s and FIA’s with income riders are both fixed income annuities that provide the ability to (a) receive income beginning in a future year, and (b) have the income be paid for the remainder of one’s life and a spouse’s life if married. The main difference between DIA’s and FIA’s when it comes to lifetime income is the start date. With a DIA, there’s a fixed start date that’s contractually defined. FIA’s with income riders have a flexible income start date that can typically begin one year after purchase or at any time thereafter during the life of the contract.

Second, unless you purchase a DIA and choose it at the time of application, lifetime income doesn’t have to begin at age 85. There’s no fixed income starting date associated with longevity insurance. You can purchase a DIA that pays lifetime income beginning at age 75. In addition, you can purchase a term DIA where income is paid for a fixed number of months or years. As an example, income could begin at age 82 and end at age 87. Furthermore, as previously explained, if you purchase a FIA with an income rider, other than stating the earliest possible income start date, a FIA contract doesn’t require you to begin taking withdrawals on a specific date.

Although DIA’s and FIA’s with income riders may be purchased to provide what’s marketed as longevity insurance, this is only one application of both products. What is thought of as longevity insurance, i.e., lifetime income beginning at age 85, accounts for a small portion of fixed income annuity product sales. While a later starting date generally will result in a greater amount of lifetime income, all else being equal, most retirees need to begin taking income distributions to cover expenses at an earlier age.

Annuities Deferred Income Annuities Fixed Index Annuities Longevity Insurance Retirement Income Planning

Insure Your Longevity

When people hear the term, “longevity insurance,” they immediately conjure up images of insurance agents trying to sell them an insurance policy. Longevity insurance isn’t a product in and of itself. It is instead one application of a couple of different types of fixed income annuity products offered by life insurance companies.

The Need for Longevity Insurance

It’s been my personal and professional experience that people generally underestimate how long they will live. Not only is it common to live to age 80, it isn’t unusual to survive to age 90 and even to 100. According to a March, 2012 report, The 2011 Risks and Process of Retirement Survey, prepared for the Society of Actuaries, when a couple reaches 65, there’s a 10% chance that at least one of the individuals will live to 100. There’s a 1% chance that one spouse will reach 107. More than half of retirees and pre-retirees underestimate the age to which a person of his or her age and gender can expect to live.

Given the foregoing facts, combined with the uncertainty of the sustainability of a traditional investment portfolio as a source of retirement income, there’s a need for a guaranteed lifetime income solution for the latter stage of one’s life. The income amount, when combined with other sources of sustainable income, needs to be sufficient to meet projected known and unforeseen expenses for an indefinite period of time.

Products Providing Longevity Insurance

There are two types of fixed income annuities that can be used for the purpose of longevity insurance: deferred income annuities (“DIA’s”) and fixed index annuities (“FIA’s”) with income riders. Both provide the ability to (a) receive income beginning in a future year, and (b) have the income be paid for the remainder of one’s life and a spouse’s life if married.

Deferred Income Annuities

Although DIA’s are currently offered by only a handful of life insurance companies, they’re the solution that’s typically been touted for longevity insurance up until now. Like single premium immediate annuities, or “SPIA’s,” DIA’s pay periodic income for a specified period of time or over one’s lifetime or joint lifetimes as applicable. Unlike SPIA’s which begin payments one month after date of purchase, the start date of DIA payments is contractually defined and is deferred for at least 13 months. The longer the income start date is delayed, the lower the premium, or investment, required to provide a specified amount of income.

Although DIA’s can be purchased for a specified term, e.g., ten years, when used as longevity insurance, the payout on DIA’s often starts in one’s 80’s and is for life. Depending upon the age at which a DIA is purchased, the premium can be a relatively small amount compared to the potential lifetime income that may be received.

Fixed Index Annuities With Income Riders

For those individuals who don’t want to be locked into a fixed starting date, in addition to providing an accumulation value, FIA’s with income riders offer greater flexibility than DIA’s. With FIA’s, which are more readily available than DIA’s, there’s no contractual income start date. Income withdrawals can generally begin any time at least one year after the initial investment is made. The longer the start date is deferred, the greater the amount of lifetime income. The start date can be targeted when the investment is purchased based on the amount and timing of initial and projected ongoing investments and desired amount of income. A flexible, vs. single, premium FIA is required in order to invest additional funds.

Depending upon one’s needs and marketplace availability, it may make sense to use a combination of DIA’s and FIA’s with income riders. and potentially multiple products within each category, to meet deferred lifetime income needs. As with all things of this nature, a thorough analysis should be prepared by a professional retirement income planner to determine the solution that will best meet your needs.

Annuities Fixed Index Annuities

Fixed Index Annuity Income Rider Similarities to Social Security – Part 1 of 4

As evidenced by the number of blog posts regarding fixed index annuity (“FIA”) income riders beginning with the December 12, 2011 post, Add an Income Rider to Your Fixed Index Annuity to Create a Retirement Paycheck, there are a lot of things to consider before adding this powerful optional benefit to a FIA.

It isn’t easy to determine which fixed index annuity income rider will produce the optimal amount of lifetime income in a given situation. This task is best left to an experienced retirement income planner who not only works routinely with this and other retirement income planning vehicles, but more importantly, understands you, your retirement income planning needs, and your overall financial situation.

As a potential purchaser of a FIA with an income rider, the easiest way to begin to understand a fixed index annuity income rider is to compare and contrast this retirement income planning strategy with Social Security retirement benefits. There are eight characteristics shared by FIA income riders and Social Security as follows:

  1. Lifetime income
  2. Entry fee
  3. Flexible income start date
  4. Increased annual lifetime income
  5. Inflation and longevity risk protection
  6. Income ceiling
  7. Portfolio risk reduction
  8. Income taxation

This post will discuss the first two, with three through five addressed in Part 2, six and seven covered in Part 3, and income taxation reserved for Part 4.

Lifetime Income

Both Social Security and FIA income riders are designed to provide their intended recipients with lifetime income. By their nature, the investment return and overall investment value of both income vehicles is open-ended and cannot be determined until the death of the recipient, and in many cases, a spouse, if married.

The income in both cases is generally considered to be guaranteed, however, the nature of the guarantee is different in each case. Although the resources backing the Social Security system are projected to be sufficient to sustain current benefit formula payments for approximately the next 20 to 30 years, there is a strong possibility that the projected increasing ratio of number of retirees to employees will necessitate a reduction in benefit levels at some point. Although the security of annuitization and income rider payments enjoy a superb historical track record, the income rider lifetime guarantee is subject to the claims-paying ability of individual life insurance companies.

Entry Fee

In order to obtain the lifetime income benefit associated with FIA income riders and Social Security, there’s an entry fee. The amount of the fee in both cases is calculated as a percentage of a predefined base and is generally, although not always in the case of Social Security, automatically deducted from the applicable funding source.

For employees, the Social Security entry fee is currently 4.2% of Social Security earnings up to a maximum of $110,100 in 2012. The calculated amount is automatically deducted from an employee’s gross salary. In addition, employers are required to pay a rate of 6.2% on the same earnings level. For self-employed individuals, the rate is 10.4% of net self-employment earnings and is typically paid, together with medicare tax and projected income tax liability, via estimated tax payments.

The entry fee for a FIA income rider is deducted from the FIA’s accumulation value. It’s calculated as either a percentage of the accumulation value or income account value, with the latter being the most prevalent. Of the 171 FIA’s offering guaranteed minimum withdrawal benefits (“GMWB’s”), or income riders, on the market today, 121, or approximately 70%, use the income account value as the basis for charging the income rider charge. 90 of the 121, or approximately 75%, charge up to 0.75% of income account value, with 52 of the 90, or 58%, falling between 0.50% and 0.75%.